Cramer on Price-to-Earnings Multiples

If price-to-earnings multiples bother you, don't buy high-priced stocks.

Sorry to be so simple-minded about this, but I am so sick of getting emailed about the high price-to-earnings ratios of specific stocks that I have to address this, if only to stop the flood of emails.

First, let's talk about P/E multiples. We are conditioned to look at trailing P/Es, meaning what a stock trades at versus old earnings. That means certain stocks, particularly high-multiple stocks in the tech world, look ridiculously expensive.

But before we lapse into Barron's-speak, can I let you in on a big secret? Past earnings don't matter. The market trades on future earnings. Let's take Microsoft. Mister Softee's trailing P/E right now is sky-high, high 40s. Whatever.

I care about future earnings.

On future earnings estimates Mister Softee is still expensive. But how about if Microsoft reports better-than-expected earnings? How about if it reports much-better-than-expected earnings in 2000? That's what I care about.

Some stocks are always going to be expensive. Cisco has never ever been cheap since it came public. Microsoft is rarely cheap. Companies that have high growth at a time when many companies can't raise prices will always have high multiples.

What should you do if you don't like these multiples? Should you short these stocks? That's stupid, I think. Valuation is NEVER a reason to short. NEVER.

There will always be someone out there who will pay more than somebody else. That person will wreck your valuation short.

My suggestion is you just avoid them. Don't email me about them. I can't do anything about it.

Insist on low P/Es? Try Bethlehem Steel. Arguably BS might be selling at 4 times earnings. LTV might even be more of a steal, at about 3 times earnings. The copper and aluminum companies sell at very low trailing multiples. Those would probably work for you, too. (Please, I am not recommending these stocks. I am using them as examples of cheap stocks that I think will stay cheap. I am not the least bit interested in these stocks.)

It's not my game, so I don't play it. I can only tell you what I do. I am not about to put out a piece recommending low-P/E stocks to satisfy those members who only invest in low P/Es. I am not a broker, it is not my job to recommend. More important, that's not my style of investing. I am trying to peer forward and see what may be cheap on year 2000 numbers, not what was cheap on 1996 earnings.

Some of you want me to change my style of investing to suit yours. Some of you want me to revile high-P/E stocks as expensive booby traps. Others want me to bash stocks that have moved up too much. One guy emailed me five times this weekend alone to get me to trash Lucent because of its high trailing P/E.

Forget it. I'll leave that to the journalists. My job is to make money. If it means buying stocks with high P/Es on trailing earnings, so be it. Investing is not a religious experience, with dogma and etched-in-stone lessons. It is not a totalitarian experience with rigid rules that when violated get you shot. It is a flexible business with disciplines checking convictions so they don't get out of control.

That's all.

Don't make it more than it is. Don't be an ideologue. It won't make you any more money and will probably blind you to great opportunities.

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